I have been meaning to post my follow up to “A look at the economy…Part One” for awhile now, but I was holding off to see what President Obama would do upon entering office.  It would appear now that we have our answer.  His response to the economic crisis impacts many of the ideas that I have, and have read online.  It is my theory that economic recovery must take place on many different fronts, not just one.  Relying on the government to solve the problems will not work.  The burden is on each and every one of us to contribute to a healthy economy.

President Obama has signed into law an economic stimulus package that is valued somewhere in the neighborhood of 790 billion dollars.  This package is designed to create jobs by investing in public infrastructure projects.  This is the largest measure ever passed, be it in the United States or the world.  The impact will not be felt immediately, but gradually.  People who are sitting by hoping things immediately get better shall be sorely disappointed.  The economy unfortunately does not work in such a manner.  As I mentioned in my previous article, the economy is a system of highs and lows.  Due to the fact that we are in a deep low, getting out will simply take longer.

This bill is only one small part of the equation, however.  When a government spends excessive amounts of money, they create a deficit.  Known as the Keynesian Effect, this spending increases income which in turn should increase consumer spending.  This in turn requires businesses to produce more goods and offer more services (known as the multiplier effect).  Consumer optimism about the economic situation is raised, and that leads to an upturn in spending.  The side effect of this, besides going into debt, is that the risk of inflation is greater.

As I am a fairly fiscal conservative personally, free-spending during a recession goes against my grain.  The reason that I do not agree with it is that it is merely a stop-gap solution.  It does not fix the problem long-term; it only plugs the holes for the short-term.  Rumor has it that the Obama administration is considering another stimulus bill in excess of one trillion dollars.  Despite its status as the world’s largest corporation, even the United States Government has limits.  At what point do they run out of money?
One must also consider what some of the money is earmarked for, and whether or not these are appropriate purchases.  Some fringe examples are as follows:

• $50 million for the National Endowment for the Arts.  (If the art was marketable, people would buy it!)
• $4+ billion to ACORN (Association of Community Organizations for Reform Now).  (How will this group stimulate the economy measurably?)
• $650 million for digital-TV coupons. (Whoever is in charge of this department should be fired for completely underestimating their budget.)
• $90 million towards digital conversion education of “vulnerable populations” (in addition to the aforementioned $650 million, and what has already been spent).  (Hey dummy, you need a digital converter box or your TV will no longer work!  No more Pro Wrestling or NASCAR!)
• $4.2 billion for “neighborhood stabilization activities.” (What in the blue hell is this?)
• $300 million to combat violence against women.  (This is why we have the police, no?)

The United States pulled itself out of the Great Depression by investing in the assembly line and road work.  Additionally, they had the added economic benefit of being drawn into World War II.  This increased employment dramatically by allowing women to join the work force (as many men were in the military fighting).  This is what President Obama is trying to emulate.

To promote a healthy economy over the long term, there are a number of other factors that must be addressed.  To add a disclaimer, please bear in mind that I am not an economist, an accountant, or a financial advisor.  I am merely an average guy who has spent a couple of months reading about economic principles.  The suggestions that I have cultivated within the paragraphs below should be applied simultaneously.  One or two may improve the economic outlook, but would certainly not fix the greater problem.

The easiest problems to rectify first are internal.  Unemployment insurance and welfare are a burden upon the government and the taxpayer.  The system allows for far too much freeloading, and there is no return on the monies allocated to claimants.  This system should be altered to a workfare system.  This system would provide the same amount of funds to any claimant, but would require their participation in education and skills enhancement programs.  It would also put greater emphasis on job placement, and provide financial incentives to potential employers.

These programs would increase the number of skilled workers within the country, and decrease the amount of people on the system.  These programs would cost the government significantly more in the short term than the programs currently in place, but the long-term benefits would overshadow the cost. 

These programs should be setup as a no-interest, no-payment loan to the individual.  However, to have the loan completely forgiven, those who go through the program would be required to work a certain amount of years within the country.  This would insure that the country reaps the benefits of the taxpayer-funded education that was invested in the individual.

Secondly, a far greater emphasis needs to be placed on small business.  Mark Cuban said it best.  “Entrepreneurs who start and run small businesses will be the propellant in this economy.”  Mark Cuban is an entrepreneur.  He is considered the father of High Definition (he founded HDNet in 2001), and he is the owner of the NBA’s Dallas Mavericks.  His current net worth is 2.3 billion dollars.  He has started and sold his fair share of companies.

Funding should be made available to individuals with new and innovative ideas that employ people and can be profitable within a short period of time.  Not every idea is good, but every idea is worth listening to.  To his credit, Mark Cuban has put his money where his mouth is.  Please see the links below for his list of rules, and take a look at the responses that he has received.

http://blogmaverick.com/2009/02/09/the-mark-cuban-stimulus-plan-open-source-funding/
http://blogmaverick.com/2009/02/17/the-stimulus-plan-update/

His rules are strict, and some are controversial by some peoples standards (such as publicly posting business plans and the theft of ideas).  However, it is his money, and he is a businessman.  In as much as he wants to help small businesses, he sure does not want to do so at a loss!  That would be counterproductive.

The government should follow Mr. Cuban’s example.  They could use virtually the same rules, and do it on a much larger scale.  The key to doing so would be turnaround time and a streamlined process.  Typically, getting anything out of the U.S. Small Business Administration is difficult, confusing, and time consuming.  This leads to frustration and people abandoning their ideas.  This would have to change.

This branch of the government should be able to operate with close to zero loss, as it would be setup to run much like a venture capital corporation, and more.  Once a prospective entrepreneur submits a business plan, it is reviewed by knowledgeable peers to determine if it has merit, and what the operational costs will be.  Profit and loss are also discussed, as well as how the government gets a return on their investment.  I should clarify here that the intention of the government is not to make money off of entrepreneurs, but rather provide them with the necessary capital to either take their business to the next level or get one off the ground.

Additionally, it should be clarified that it is not the government’s job to prop up failing businesses (I am referring to the bailout bill here, not the stimulus package).  We have a free market economy and a capitalist society, and we should let that run its course.  When companies fail, new ones will take their place.  It’s the law of supply and demand.

Companies such as Chrysler, GM are failing due to their mismanagement.  Propping them up with federal monies (i.e., taxpayer dollars) does not fix the problem.  The simple fact is that there will always be a demand for cars.  If these companies shut down, new ones will take their place.  If they want to succeed, then they should do what every successful business does.  They have to develop products to be sold at a price that people want to purchase them for, and then they have to manufacture them for less than they are selling them for.

The next step would be to rectify the trade deficit.  In 2006, the United States had a trade deficit of 817.3 billion dollars.  In simple terms this means that the United States purchased goods and services totaling 817.3 billion dollars more than other countries purchased from them.  Without rectifying the trade deficit, the economic stimulus plan will be worthless.

The raw numbers are staggering.  The United States borrows three billion dollars a day to cover the interest on its debt.  The debt burden as a proportion of GDP is around 350%.  This means that the debt is three and a half times the total output of the economy.  The trade deficit with China is almost 500 million dollars a day.  China has dollar denominated reserves of approximately 1.5 trillion dollars.  In total, the United States owes Asia over two trillion dollars.  At the current rate, it will be three trillion dollars within a few years. 

In a strong growth economy, a reasonable trade deficit is not a problem.  When it reaches almost a trillion dollars in a given year, however, there is serious cause for concern.  The goods being manufactured in your country are not being purchased, causing factories to outsource labor to foreign markets, or being shut down completely.  This in turn leads to higher unemployment and a lower GDP.

Most corporations exist to make money for their shareholders.  They are not charities, and are generally motivated by profit.  Their objective is to generate as much revenue as possible while minimizing expenses.  It is capitalism at its best.  Once that concept is clearly understood, you can see why they choose to outsource labor to countries such as Mexico and China.  The average American worker will earn approximately $20.00 per hour.  The average Chinese worker will earn $0.20 cents per hour.  Multiply that cost over thousands of employees, and the cost differential becomes very evident.

In addition to the labor, certain foreign governments also subsidize the material used by native companies to manufacture goods.  Due to the fact that this is not done by governments in a free-market economy such as ours, it offers a competitive advantage to foreign made product.  This competitive advantage is supposed to be negated by tariffs on imported goods, yet often it is still not enough.

One cannot blindly sit back and place the cause of the trade deficit onto the shoulders of corporate America, however.  Consumers also share the blame as they often look for the lowest possible prices.  If you have two identical products, one manufactured in the United States and another manufactured in China, and the Chinese product is 20% cheaper, which one will you buy?  A tariff is designed to negate the cost differential, yet oftentimes it does not work.

To balance the trade deficit, the existing tariff system should be replaced.  In 2003, Warren Buffet, the billionaire investor and chairman of Berkshire Hathaway, proposed a system known as Import Certificates in order to avoid the economic crash that he foresaw on America’s horizon.  The plan would be phased in over five years, with the exception of oil, which would be ten years.

The way the plan works is simple.  For every dollar that is exported from the United States, an import certificate for the equivalent amount is issued to the exporter.  The import certificate entitles the bearer to import an equivalent amount of product into the United States.  Given that we are in a free-market economy, the exporters could sell these certificates to the highest bidder which would allow them to import their goods.

For example, if the United States exports $500 billion worth of goods, then $500 billion worth of import certificates would be issued during that time frame.  If $1 trillion worth of import certificates are desired by importers, they would have to bid and compete over the available supply.  This would allow the exporters to make additional money, while it would cost importers additional funds to import their products.  If the United States was to run a trade surplus, there would be more import certificates available than desired, which would result in free trade.

This brings us to two questions.  What would happen if foreign countries that hold exceptional dollar reserves unleash them upon the market, and would they consider doing so?  While conventional wisdom may suggest that by doing so they would cripple the U.S. economy completely, it is unlikely that they would do so.  If they did such a thing, they would in effect be cutting their own throats because their investments would become worthless.  With respect to China, if they were to flood the market it would result in a loss of approximately 5% of their own GDP.  The ancient truth is that when the debt is large enough, it’s the debtor who has the power, not the creditor.

The final stage of the process is monetary reform.  As I mentioned in Part One, the large banks have created a system by which fractional reserve banking is the norm.  Fractional reserve banking allows the banks to essentially create money out of nothing.  The government borrows this money and pays the banks back with interest.  Those interest payments alone in 2007 totaled $465 billion, which was 17% of the U.S. budget that year.

The net effect of eliminating both fractional reserve banking and the national debt would put an end to the up-and-down activity of the U.S. economy.  It would also remove private lenders (such as banks, or the Federal Reserve for that matter) from being able to influence policy decisions.  Many people are unaware that such institutions such as the Federal Reserve, the World Bank, and the International Monetary Fund are all private corporations.  Due to the existing laws (Primarily the Federal Reserve Act of December 23rd, 1913), these corporations are able to report record profits because they are able to create their own money, and then charge interest on it!

The solution is to eliminate fractional reserve banking by requiring banks to increase their reserves on deposits to 100% over the course of a given period.  Simultaneously, to provide the necessary funds for this increase, the government would issue new “certificates of value” in sufficient quantity to pay off the debt.  The government would dispose of the Federal Reserve Notes as they are returned.

There would be no net increase to the money supply due to the fact that both of these actions cancel one another out.  It would cause neither inflation nor deflation.

All of these actions would result in economic stability. As the United States of America is the only superpower left (and that’s precarious at best), the world economy would stabilize as well. Other governments would see the wisdom of the policies enacted, and would likely attempt to emulate them.